We're introducing a new twist on pairs trading which will improve our cost basis by adding a Theta component via shorting options in Exchange Traded Funds (ETFs) that mimic the futures pairs trade with which we started. You don't have to be a pairs trader to benefit from this.
The idea behind our pairs trades is to find correlated products that are currently diverging in order to take advantage of the expected return to their previous patterns. Stock index futures such as /ES, /NQ, /TF and /YM are one group and /GC and /SI are an example of another.
We can sell premium in the ETFs that correspond to the futures in the pairs trade. This takes things a step further by adding a Theta component.
The first step is to identify a potential pairs trade. A table of the S&P 500, Nasdaq 100, Russell 2000 and Dow Jones from September 29th to December 3rd was displayed. The table included the index, correlated future and the move off their lows. The table revealed that the Nasdaq was the strongest index and the Russell was the weakest.
A second table introducing a possible pairs trade being short the /NQ (Nasdaq future) and long /TF (Russell 2000 future) was displayed. The table included a quote price of the future, the multiplier, the notional value, the number of contracts and the total notional value of each.
We will reduce our basis and increase the trade’s probability of success by adding the theta component. Additionally, if we experience a further divergence that hurts our position we have about 1% directional protection in both indices. We look to under-hedge each position using their corresponding ETFs by selling options equivalent to half the number of shares per futures contract.
A table showing the corresponding ETF and shares per 1 future for both the Nasdaq-100 and the Russell 200 (/TF) was displayed. Another table of adding a theta component to the futures pairs trade (short /NQ and long /TF) was also displayed. The table included the corresponding ETF, position, credit received, total premium and futures points covered.
Watch this segment of “Market Measures” with Tom Sosnoff and Tony Battista for the takeaways of using ETF options to allow us to add a Theta component to a futures pairs trade and improve our cost basis.
This video and its content are provided solely by tastylive, Inc. (“tastylive”) and are for informational and educational purposes only. tastylive was previously known as tastytrade, Inc. (“tastytrade”). This video and its content were created prior to the legal name change of tastylive. As a result, this video may reference tastytrade, its prior legal name.
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